What Moody’s doesn’t say in its recent report on higher education

 Moody’s Investor Service recently put out a report entitled Global Recession and Universities: Funding Strains to Keep Up with Rising Demand. It provides a very interesting and informative view of some aspects of the higher education scene as observed from outside of the system. The report came to my attention through posts in GlobalHigherEd (on whose server the report above resides) and University World News, and I thank both for their nice articles.

Moody has looked at universities at selected areas around the world, and how they are handling the global downturn.  Moody’s ultimate interest, of course, is to be able to rate these universities as they access capital markets, so the focus is on aspects of the environment that can or will impact their financial stability.  I will describe some of their observations that I find most interesting, and then will talk about the part of the report that I find most important - the things that are not said.  I will not try to describe the whole report, but recommend that you simply read the original - it is only 13 pages long. I also will focus on the parts of the report that refer to US universities, since that is the group that I know the best.

As a minor point, the report emphasizes public institutions, stating that public universities “most likely accounting for between 80-90% of all students enrolled in tertiary education.” A recent OECD report claims that private higher education now accounts for 30% of tertiary enrollment globally.  This relatively minor discrepancy does not invalidate any of the conclusions of the report, of course. 

Moody’s notes that recessions generally lead to enrollment increases for a variety of reasons, but warn these increases may not be uniformly distributed:

While enrolment declines are possible at individual institutions due to particular market, reputation, and management challenges, we expect higher education overall to enjoy a significant “tail-wind” in student demand for spaces over time. This is especially likely for universities that are “access” oriented with less restrictive academic requirements and a mission focused onskill development. Many prominent universities that function as comprehensive research institutions focused on maintaining strong academic quality reputations and high entrance standards may see the greatest impact in their advanced degree programs.

On the other hand, Moody makes a strong point regarding fundamental changes in funding:

Moody’s believes that the magnitude of economic changes in some countries may place pressure on historic funding and financing patterns of higher education. This would likely be driven by two conflicting trends– increased policy directives to expand university programs and more limited ability of governments to fund the desired expansion Not surprisingly, many countries now face significant budgetary challenges with large competing demands on government dollars.

While some aspects of spending on higher education have been temporarily boosted through stimulus spending, this is largely financed by government deficits and may be difficult to sustain beyond the near term. At the same time, the desire for rapidly rising investment in higher education to support higher participation rates and expanded research capacity suggests the need for significant new operating and capital dollars over an extended period. These trends may well become clearer as the ability to fund higher education comes under greater pressure.

In  regard to this desire for greater revenues, in the understatement of the year, Moody’s cautions: raising student fees is usually a politically sensitive decision.

For the US, there is a timely warning regarding globalization:

In general, we also believe the level of global competition and pooling of talent for faculty and students will continue to increase. As U.S. universities cut back significantly on hiring and capital spending,  non-U.S. faculty and students may be susceptible to recruitment to
other leading universities or home countries. Over the past three decades, the number of students enrolled outside their country of citizenship has risen dramatically, from 0.6 million worldwide in 1975 to 2.9 million in 2006, a more than four-fold increase. Developments like the Bologna Process in the European Union, and similar efforts in other regions, may further encourage the trend of crossing borders to enroll in higher education.

Overall, Moody’s is looking at financial stability impacts of increasing student demand (good), research funding (good), uncertainty of state funding (bad), conflicting demands for services (mixed), political pressures(bad).  So what is missing?  Actually, it is not so much that something is missing, but that the financial problems and dangers become clearer if one looks at them from a slightly different angle, one that will be familiar to readers of this blog.

First, at universities - both public and private - the cost of providing education is higher than the price paid by the students.  Thus the major difference between the two sectors is how this unmet cost/price deficit is covered. Strong undergraduate student demand is rightly viewed as a positive by Moody’s.  Any drop in undergraduate enrollment generally translates directly into a budget deficit.   In addition, with strong undergraduate demand, institutions have more flexibility in setting their “discount rate”, (net financial aid as a percentage of net published tuition) and in increasing tuition annually . Thus strong demand enables institutions to have a predictable, increasing budget  which minimizes- but does not remove - the structural excess cost per student that must be covered by other sources. 

Secondly, a similar difficulty occurs with research. Moody’s finds it positive for the balance sheet that federal stimulus funding for research is increasing.  However, universities lose money on almost every federal or private research grant that comes in.  Sponsors have for a long time required universities to put up matching funds, and that pressure is growing; construction costs for expensive laboratory buildings are only partially reimbursed even in the best grants; sometimes explicit policies of “non-complete cost recovery” decrease even the recovery of nominally allowed expenses; research faculty able to compete successfully for grants are much more expensive than the norm; the list goes on.  Research is a core part of the mission of research universities, of course, so research grants are eagerly sought - the core mission could not be advanced without them.  However, from a balance sheet perspective, a new grant simply means the institution must find money from another source to cover the costs of the research that are not paid by the sponsor.  Thus, it is positive from the standpoint of mission that stimulus funding for research is increasing, but from the standpoint of balance sheet, it just mean another negative pressure, another unmet structural cost/price deficit to be met from other sources.

The third reality is that the costs of both research and education grow more rapidly than the CPI and it is unlikely that this can be changed in a sustainable way without significantly changing the current models for both. 

Put this together, and the emphasis in looking at financial stability turns to the question of price, and of sources to meet the certain cost/price deficit. In the educational component of the budget, private universities in the US have been successful in constraining growth of the cost/price deficit by increasing price at significantly more than the CPI for several decades. However, as a result of this strategy, the cost of private higher education is increasing faster than family income for 90% of families in the US, the earnings value of a degree compared to its price has been decreasing, and political pressure has been growing steadily to restrain these price increases, perhaps by law. Thus it seems to many observers quite likely that the strategy of annual large price increases will not survive much longer. Any significant constraint on higher- than-CPI tuition increases would greatly increase the cost/price deficit, thus increasing pressure on alternative sources of funding.

On the public side, there are also constraints on raising price resulting from both political pressures and mission concerns(e.g. universal access). Mission obstacles may possibly be overcome by moving to high tuition, high aid models that assure access independent of financial situation. Political obstacles in many cases are likely to be more serious.  Whatever happens in the short run, however, it seems unlikely that public institutions will be allowed to adopt the private university model of yearly above CPI increases, so the pressures on alternative funding will occur here as well.

On the research side, universities seem to have little price leverage. There is little enthusiasm in Washington to increase the indirect costs component of the research cost.  As Moody’s rightly observes: Many universities believe this portion of government support is woefully under-resourced. Similarly, corporations are happy to shop their needs around, looking for the university provider who will set the lowest price. Thus, increasing price of the research component to meet cost seems quite unlikely.

Turning to alternative sources of funding to meet these deficits, we actually find very few that are significant at this time. Primary are the state, and philanthropy.  Moody’s does a good job of describing the significant uncertainties and long term trends in state funding. Suffice it to say that it seems unlikely that the state will rush to the rescue. Moody’s also describes some of the difficulties in increased dependence on philanthropy, focusing on many of the recession related negatives .  There is, however, a large negative that I did not see mentioned: the greatly increased competition for philanthropic dollars. Not only are the public higher education institutions now aggressively seeking philanthropic dollars that previously would have gone to their private peers, but the philanthropic needs of other cultural, health, and welfare organizations have skyrocketed with cutbacks in state spending.  Add to that the new found interest in Europe and Asia in philanthropic support of local higher education and you have another segment of philanthropic resources that is suddenly becoming much more difficult to access.  In brief, I think neither of the two primary sources of the funding for the structural deficits of higher education can be expected to meet the likely increases in those deficits.

If we turn to secondary sources of revenue to meet the cost/price deficit, we find few that are broadly significant. In Australia and England, a strong secondary source of revenue for many institutions is international students, taught both at home and abroad.  For NYU and a few other institutions in the US, continuing education provides significant revenue. For several institutions such as NYU, Columbia, UC, and MIT, IP licensing provides considerable income.  It seems obvious that it will be increasingly critical for institutions of higher education to develop these and other secondary sources if they want to be able to meet their structural core cost/price deficits without harming mission. It is not clear that all will be able to find secondary revenue niches that are sufficiently robust to protect mission.

So overall, I think Moody’s is right in saying that most universities are a pretty good bet from the perspective of being able to repay their debts.  What is much less certain is the fraction of universiiesthat will be able to successfully fulfill their missions at the same time.